"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."--F.A. Hayek

">

04 March 2012

Iran, Oil & Acts of War

The price of oil is rising while supply hasn't changed and domestic demand is flat (if not down a bit) and world demand is stable. Why?

The answer is speculation and futures trading. Traders see developments in oil producing countries and try to predict the effect the events will have on the price of oil in the future and place bets (or hedges) on what the actual price will be.

It is important to remember that for every seller there is a buyer, so for every trader that thinks prices will reach $x by a particular date, there is another who thinks that he is wrong. Perhaps not in the direction of prices, but at least in what he believes the price will be.

The latest spike in the price of light, sweet crude came when Iran said it would stop supplying oil to British and French firms. This is on top of Iranian threats to block the Strait of Hormuz. Iran's actions are in response to global pressure regarding its development of nuclear technology, ostensibly for peaceful, energy-producing reasons but really as a hedge against western/Israeli hegemony in the region.

As to the price of oil, there are a few things to keep in mind. Oil is a fungible commodity. It is wise to note that while Iran is cutting sales to certain European nations and some firms, Iran is not cutting total sales and/or production. Just because they will not sell 620 million barrels of oil to Europe, doesn't mean that they are not going to sell those 620 million barrels. They will get sold to other countries or firms (and, through arbitrage and intermediaries, much of that oil will end up in Europe anyway). Oil that would have been sold to Europe will be sold to other countries and firms. This will mean that Russia or China will get more Iranian oil while Europe will get more oil from other oil-exporting countries.

So aside from some increased transactional costs, resource shifting and minor blips with speculators, world supply and demand will have remained virtually unchanged.

Now, to the matter of Iran threatening to cut off a significant amount of the world oil supply by blockading the Strait of Hormuz... it ain't gonna happen.

This would be an act of war. And not in the George W. Bush neocon sort of act of war. Tankers sail in and out of Hormuz daily, some under the American flag. If Iran put up a blockade, any country would be derelict in simply allowing the blockade to sink their vessels. The US would be well within her rights to send a carrier group in and, to use a Hunter S. Thompson-ism, "soften up the joint a little bit." It would also make the first war with Iraq look like some sort of morass. With the Navy and Marines having fun in the surf, Israel would be only too happy to take care of neutralizing any air support and Iranian communications infrastructure. It could be the shortest comprehensive trade war in human history.

Anyway, the price of oil is up though there is no significant change in either supply or demand. Traders are trying to figure out what exactly will happen (while making money along the way) and the media is breathless, yet again, with stories covering the price of oil without ever entertaining any sort of thought about why prices are what they are and what information they provide us with. Keep up the great work, you Fourth Estate, you.